Christine Norstadt and Katie Fish’s article on “Five Topics to Consider When Negotiating Default Provisions in a Purchase and Sale Agreement” in the Daily Report
“Five Topics to Consider When Negotiating Default Provisions in a Purchase and Sale Agreement”
by Christine Norstadt and Katie Fish
As transactional attorneys, we like to be deal “makers,” not deal “breakers.” However, when preparing a purchase and sale agreement, even the most optimistic of deal makers ought to consider the possibility that a party might breach the agreement. Below we discuss topics to consider as you draft and negotiate the default and remedies provisions of a real estate purchase and sale agreement:
- Notice of default and opportunity to cure. Ultimately, the spirit of the deal is to consummate the transaction, and both parties likely want to avoid a default. Accordingly, consider including a notice requirement and a time period for the breaching party to cure its default. There are some logical exceptions to the notice and cure period right, though, and so certain carve outs are appropriate. For example, there should not be a cure period if the purchaser fails to tender the full purchase price at closing.
- Disbursement of the earnest money deposit. In the event of a seller default, the agreement should obligate the escrow agent to immediately disburse the earnest money to the purchaser (i.e., without the need for seller’s approval to do so). Conversely, in the event of a purchaser default, the parties customarily agree that the earnest money will be paid as “liquidated damages” to the seller.
- Recoupment of pursuit costs. In the event of a seller default, in addition to the return of the earnest money, a purchaser may want to require the seller to reimburse it for costs associated with the purchaser’s due diligence so that it will be truly made whole after the seller’s breach. Such “pursuit costs” typically include the cost of third-party reports (e.g., Phase I Environmental Site Assessment, Property Condition Report or Zoning Report), title examination charges and survey costs. We recommend drafting broadly so that the remedy picks up any other costs which the purchaser may have incurred, such as pre-closing loan fees and deposits and travel expenses. In response to a request to reimburse pursuit costs, a prudent seller will often negotiate for a dollar amount cap on the total amount of the reimbursement, for a limitation that the pursuit costs be truly out of pocket, third party expenses and finally, that the obligation is only triggered upon an intentional default by the seller (as opposed to an unintentional breach, such as a representation or warranty no longer being true, but through no act or omission of the seller).
- Specific performance. As an alternative to the monetary remedies described above, specific performance is an appropriate remedy for a purchaser in the event of a seller default because real estate is unique, and as such, monetary damages would not be adequate compensation for the breach. Specific performance is a legal proceeding whereby the purchaser seeks equitable relief from a court ordering the seller to sell the property to the purchaser. The purchaser should seek to recover its fees and costs incurred in pursuit of the specific performance action as part of this remedy. The remedy of specific performance is typically not available to sellers because sellers have an adequate remedy at law via the payment of the earnest money which adequately compensates the seller for the purchaser’s breach, and the payment of the purchase price is not unique.
- Liquidated damages. Specific performance will not be available to the purchaser if, prior to the issuance of a court order, the seller sells the property to a “bona fide purchaser” (i.e., a party who was not aware of the seller’s prior contract to sell the same property to the original contract purchaser). To protect itself, a contract purchaser may negotiate for liquidated damages payable by the seller if the seller willfully breaches the purchase and sale agreement by selling the property to another party. These liquidated damages may by equal to a pre-determined amount or linked to the amount realized by the seller in connection with the sale of the property to the bone fide purchaser. A liquidated damages provision may also be appropriate in other situations, such as a scenario in which the property is “replacement property” for the purchaser’s 1031 exchange and the purchaser faces significant and negative tax consequences if it cannot consummate the transaction within the requisite time period. These tax consequences are quantifiable and therefore a good starting point for developing a liquidated damages amount for the purchase and sale agreement. Finally, as discussed in item 1, the payment of the earnest money to a seller after a purchaser’s default is also a remedy of liquidated damages. Liquidated damages must meet the following conditions to comply with Georgia law: (1) the injury caused by the breach must be difficult or impossible to estimate; (2) the parties must intend to provide for damages; and (3) the sum stipulated must be a reasonable pre-estimate of the probable loss. It is good practice to incorporate these statutory concepts into provisions related to payment of liquidated damages in the purchase and sale agreement to ensure that the provisions are enforceable and not deemed to be a penalty.
Purchasers and sellers should also consider planning for potential post-closing defaults and appropriate remedies. Examples of post-closing defaults include breach of a representation or warranty during the survival period and failure by one party to pay its share of prorated taxes and expenses based on estimates at closing, and finally determined post-closing. A purchaser may seek to protect itself for such post-closing breaches by requiring funds be held back in escrow at closing or imposing a post-closing net worth requirement on the seller.
When representing either purchaser or seller, one must anticipate undesirable outcomes and mitigate the risks through careful drafting of the default and remedies provisions. Carefully drafting default and remedy provisions in a purchase and sale agreement and addressing topics such as the items discussed in this article will provide clear direction in the wake of a breach.
Reprinted with permission from the December 21, 2022, edition of Daily Report © 2022 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or email@example.com.